Putting the property craze back into perspective

Posted On Monday, 24 October 2005 02:00 Published by
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PROPERTY has been a regular dinner-party topic over the past few years.

23 October 2005

PROPERTY has been a regular dinner-party topic over the past few years.

First it was the phenomenal rise in residential property prices, then everyone talked about how much money they expected to make from their buy-to-let bachelor pad and now many investors are eager to get in on the action on the listed property market.

Property market returns have indeed been impressive.

Residential property values have been spiralling upwards for the past five years, reaching a peak annual increase of 32.2% during 2004 before slowing to just under 20% this year.

The Listed Property index on the JSE has soared 27% this year after achieving 40% last year.

South Africa has not been alone in experiencing such buoyant conditions.

The US, UK and Australian property markets have also been on the boil for the past few years, with rising housing asset prices triggering massive consumer spending in these developed countries.

•Property boom fuels wealth effect

In fact, economists and central bankers have increasingly drawn attention to the wealth effect that has arisen from such steep increases in asset prices.

According to the theory, fluctuations in household saving ratios to income are strongly related to changes in the value of household wealth holdings.

When there’s an increase in perceived wealth, as witnessed during the past few years, households tend to save a lot less. Across the rich world, there has certainly been a shift away from thrift, with household savings in countries such as US, Canada, UK, Australia and New Zealand falling sharply since the mid-80s.

Traditional high savers like the Japanese have also seen their savings rate decline from nearly 20% to slightly more than 5%.

South Africa is no exception. Despite witnessing the second-highest rate of growth in high-net-worth individuals in the world between 2003 and 2004, South Africans are spending more and saving less.

Households spent an average of 99.1% of their disposable income in 2004, with household debt as a percentage of disposable income rising to 61% during the first half of this year compared with 56% last year.

Much of the rise in debt has been as a result of individuals taking out mortgages to finance increasingly expensive residential property, with mortgage advances as a percentage of total debt moving towards 90% compared with below 50% in the early 90s (see graph).

The Reserve Bank has begun to voice its concern at the burgeoning appetite for debt, given a slowdown in property price increases and the possible effect of a rise in rates on heavily indebted South Africans.

The bank believes households’ recent low propensity to save has stemmed from the increase in the net wealth of the household sector.

In its June Quarterly Bulletin, the central bank says the net wealth of the household sector as a percentage of annual disposable income is estimated to have increased unabatedly to 234% during the first half of 2005 from 204% two years before.

Globally, concern has been mounting about whether the run-up in house prices might prove to be a bubble — painfully reversing the wealth effect.

In South Africa there are already signs of house prices tapering off and Old Mutual property executive Colin Young is concerned that listed property’s impressive run may be coming to an end, advising that there could be a slowdown, and even potential capital losses in the short term due to cyclical upward inflation pressures.

•Back to basic investment principles

At this point, it is advisable to take stock of what proportion property comprises in your overall investment portfolio and to go back to the basic investment principles.

The most important of these is to be invested in a properly diversified portfolio; one that is not overly weighted towards property.

Young, who is Old Mutual’s listed property fund manager, notes that internationally the correct amount of property in a portfolio that would have maximised one’s long-term return ranged between 10% and 20%, depending on the country.

With many individual investors viewing their residential property as a retirement asset and others who have buy-to-let second properties, that proportion is likely to be a lot higher now for them.

Given the proven benefits of diversification, investors shouldn’t rely on their home as their primary retirement fund asset.

While they may be feeling a comfortable wealth effect for now, few investors actually compare the annual increase in value, less transaction costs, in their residential properties with what they could have achieved in other financial assets, such as equities, over the same period.

Also, the value of the asset is unlocked only once it is sold and, given the general rise in property prices, it is difficult to realise that value without having to reinvest it all in another residential property — even if you trade down.

When it comes to listed property, Young notes that the rally has been based on strong underlying property fundamentals but is increasingly being driven by momentum investing.

He cautions that investors in listed property should expect pedestrian increases in the capital value and a healthy, predictable rise in income distributions.

“There is likely to be some cyclical upward pressure on listed property yields in the short term,” says Young.

“Property funds look good for the next 10 years on sound economic fundamentals. But I would advise a cautious hold for the moment because they have run hard this year.”

Property has always been an attractive investment because of the perceived security of owning “bricks and mortar”.

But experience shows that being invested across a spread of assets protects you from the risk of being too exposed to a single class when the cycle turns and also ensures you participate in the next best-performing one.


Publisher: Sunday Times
Source: Sunday Times

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